Are NFTs sustainable investments or just a short-term hype?

A friend of mine recently asked me: How can I make money in NFTs? Are NFTs a sustainable investment or just a short-term hype? Both are fair questions and having followed Web3 closely this year, I appreciate this opportunity to make sense of NFTs in 2022 from the perspective of a retail investor. Bear with me as I'm learning in public here, and please let me know your feedback on Twitter (@Copenstrand). None of this is financial advice but solely my opinion.

A quick recap of 'NFT summer'

Let's rewind to March 2021: The moment Beeple's collage sold as an NFT for $69 million, the word ‘non-fungible token (NFT)’ entered into our shared vocabulary to describe scarce, differentiable, programmable digital assets.

While you don't care which bitcoin you own and treat them all as interchangeable, in crypto, we call ‘numbered’ tokens NFTs as they are clearly differentiable. Similar to how we value uniqueness in real life, NFTs allow us to value uniqueness in digital assets. As a speculative asset, the more demand for an NFT exists and the rarer its properties and supply, the higher the price. You might appreciate Punk 6529’s thread if you struggle with the concept and this thread by Mags.eth if you struggle with terms.

https://twitter.com/cdixon/status/1469734078425485317?s=20

The Beeple sale and stories of collectors and gamers supplementing their income with NFT gaming and collecting kicked off what later became 'NFT summer' with exploding public interest pointing a spotlight on the surging number of available NFT projects. This summer, both 'blue chip', i.e. established, well recognized, pioneering NFT projects like the Crypto Punks and emerging projects alike including the Cryptoadz, CoolCats, Lazy Lions, and others saw massive temporary price increases and reached new all-time highs, as did public interest in NFTs.

The NFT ecosystem rapidly expanded with new projects, releases, and record-breaking funding across different verticals including art, gaming, virtual worlds, utility assets, music, finance, and publishing. At the same time, the NFT stack was built-out to empower creators, investors, and the community.

During this expansion phase with weekly all-time highs and mega funding rounds - e.g. Digital Candy's rise from founding in June 2021 to a unicorn just four months later - thousands of additional projects emerged, of which many in the ‘avatar’ vertical were derivatives of ‘blue chip’ projects with minimal incremental innovation.

Naturally, the sentiment had to cool off a bit

Naturally, the sentiment had to cool off a bit. With 1000+ NFT projects launching on the NFT marketplace OpenSea alone every month, and only 24 hours per day to research these, many investors were driven by FOMO. In this speculative phase, many new investors outsourced their diligence to ‘trusted’ influencers, some of which did not always disclose their incentives such as private pre-sales.

Every gold rush attracts investors chasing short-term profits, speculating to enter NFT projects early with the goal to ‘flip’ and sell shortly after at higher prices. Needless to say, NFT flipping is a zero-sum game with many investors failing to time the market.

In September 2021, investors faced another challenge: when buying or selling NFTs, you pay transaction fees, so-called gas fees. Those gas fees on the ETH blockchain increased to over $200 per transaction. This discouraged new investors from entering the space, locked existing holders into keeping their current investments, and drove them to alternative chains like Solana and Avalanche growing their NFT communities.

Additionally, many derivative projects borrowing inspiration from the same ‘blue chip’ avatar projects created fatigue in investors, and increasingly raised the question of those NFT’s utility for social signaling. Silently, the bubble began to deflate.

When it seemed that every species of Noah's arch had its own avatar project, the BAYC managed to increase their value. They did so and outperformed other projects due to their vibrant community, real-life events, and smart roadmap. The BAYC rewarded their early adopters with the possibility to combine their Bored Apes with serum vials to gain an additional rare Mutant Ape.

My key takeaway from this phase: while most current NFT projects will lose their value - and smart people expect this to be the scenario - NFTs as a vehicle are not to blame, but will create incredible value in the future. Alexis Ohanian phrased it perfectly, expecting [for NFTs] that:

99.999% are going to be worthless. But 99.999% of ALL paper is worthless, but the medium isn't flawed, it just hasn't got art from Picasso on it."

Acknowledging that we're still very early and the ecosystem is growing rapidly, how do you best position yourself as a prospective NFT investor?

The outlook for 2022

https://twitter.com/Zeneca_33/status/1469470615518257153

Before considering an NFT investment, you might want to consider a handful of factors: your investment time horizon, your time budget for research, the amount to invest, and areas you have high conviction in.

I believe that long-term investors in NFTs will outperform short-term profit chasers. While @Zeneca_33’s poll in December 2021 captured bearish short-mid term sentiment - and we might see temporary corrections clearing out overvalued projects - I’m long-term bullish. I believe that NFTs are the superior vehicle to ensure creators capture a fair share of their value created, directly engage with their communities, and bridge the virtual and physical space. From history, we know that music, gaming, and sports are strong drivers of change and can carry NFTs into the mainstream - and we see first signs from Adidas’ recent collaboration with the BAYC or Nike's acquisition of NFT studio RTFKT. If you invest long-term based on fundamental criteria like utility, strong teams, vibrant communities, and good partnerships, you can safely ignore short-term volatility.

Investment strategies for retail investors

Most new investors likely underestimate the time commitment required to keep up with the changing NFT landscape. I suggest you really take your time to analyze and identify winning projects to invest in. If you're stretched for time to do your own research, there are still options to benefit from the general value created in NFTs. Here are some approaches ranging from lowest to the highest effort required:

The probably easiest way to benefit from NFTs is just holding ETH. Most NFTs are still sold in ETH and as an ETH holder, you'll benefit as the ecosystem grows and the number of transactions increases.

Alternatively, you can invest in an index, such as the ‘blue chip’ NFT index fund by Bitwise or the Index coop metaverse index ($MVI), which currently holds 15 ETH-based tokens with a market cap of over 50M being traded over 3 months.

In contrast to investing in NFTs directly, you might prefer a ‘pick-and-shovel’-strategy and invest in underlying blockchains and platforms which enable NFT creators and marketplaces. These infrastructure and sidechain projects summarized in Messari’s NFT stack above include e.g. Immutable X, Flow, and WAX.

If you have more time and conviction towards specific verticals, you might want to invest in projects directly, e.g in avatar, gaming / play-to-earn, or digital real estate projects. If you want to learn more, stay tuned for my next posts, or dive into Arthur Hayes’ post unpacking the social dynamics of NFTs, Elimy.eth’s overview of avatar projects for each budget, or @adamagb’s good hints on picking good projects.

Last but not least, you’ll need to define how much exposure to NFTs you want. There is no ideal allocation into NFT vs. other assets, but you might want to spread your risk across projects and potentially even across layers in the NFT stack. This is especially relevant as ‘blue chip’ avatar projects like the BAYC are priced at 40+ ETH at the time of writing, making diversification a challenge if you’re not investing in indices.

Closing

I hope you got value out of this. If you have questions or feedback, please write me on Twitter @Copenstrand as I share what I learn on Crypto and Web3. Thanks to @Bernard, q_sztrwqs, Asbjorn, and Ari for improving this post with valuable thoughts. 🤝

The header image portraits the renaissance capital of Florence. Credits to Jeff Ackley.